Tax Updates: 2 December 2024

Welcome to this week’s review of tax issues where Richard comments on what’s been happening in the world of tax over the past week. If you have a question or would like a second opinion on any national or international tax issues, please contact Richard via email at richard@gilshep.co.nz.

Overdrawn shareholder current accounts

While I was slumming it overseas recently, Inland Revenue (IR) released an interpretation statement (IS) titled “Income tax – Overdrawn shareholder loan account balances,” which has the reference IS 24/09.

The document is 43 pages in length and provides guidance in relation to the most common income tax issues that will arise for both the company and the shareholder when the shareholder has overdrawn their current account, including:

• Dividend/Fringe Benefit Tax (FBT) issues where the shareholder pays no or low interest on their overdrawn balance;
• Interest income timing and quantification issues for the company under the financial arrangement (FA) rules;
• Resident withholding tax (RWT) deduction obligations for the shareholder and tax credit claims by the company;
• Income tax deduction issues with respect to the interest paid by the shareholder;
• Investment income reporting obligations for the shareholder; and,
• Dividend/FA issues whenever a shareholder is relieved from the obligation to repay their overdrawn balance.

For those of you who do not know what a shareholder current account is, it is, in essence, an account that reflects the shareholder’s investment in the company – often what funds the shareholder has lent to the company – which is why it is also often referred to as a shareholder loan account. Occasionally, however, the shareholder will have taken more out of the company than what they have put in, so just like a bank account, the shareholder has overdrawn on their account balance, so in effect, the company has now made a loan to the shareholder. The easy fix to avoid any negative income tax implications is to ensure that the company charges the shareholder interest on the overdrawn balance at an interest rate that is at least equivalent to the FBT prescribed interest rate.

Where interest is not charged on the overdrawn balance (or is at a rate less than the prescribed rate), determining whether the value transfer (the short charged interest amount) is a dividend or a fringe benefit is then dictated by the employment relationship which the shareholder has with the company. If the arrangement is one of shareholder-employee (in simple terms, when an employee holds shares in the company), then the dividend exclusion rules will apply on the basis that a fringe benefit provided to a shareholder-employee that is subject to FBT is treated as not being a dividend – so FBT should be paid on the value transfer. Note that the rule which enables a company to choose whether to apply the dividend or FBT rules only applies to unclassified benefits, which an employment-related loan is not.

When the dividend rules do apply, the dividend is usually treated as being paid six months after the end of the company’s income year. Note that in calculating the dividend amount, in some cases, payments made by the company to the shareholder, fully imputed dividends, for example, can be retrospectively credited against the overdrawn current account balance.

From an income tax deductibility perspective for the shareholder, the funds drawn from the company will usually be for private or domestic purposes. Consequently, the shareholder will not qualify for an income tax deduction in relation to the amount of interest paid to the company. If, however, the shareholder uses the funds for income generating purposes, then a deduction for the interest paid may arise. Equally, where the shareholder does not pay the interest as part of a taxable activity, which they carry on, then the shareholder will have no obligation to deduct RWT from the interest payment.

Finally, when a shareholder is released from the obligation to repay an overdrawn shareholder current account, a deemed dividend will arise, being the market value of the loan forgiven at the time (note in the course of a liquidation, the dividend amount may be reduced by any available capital distribution amount and any available subscribed capital in the company). While the FA rules are usually also triggered, which require a base price adjustment (BPA) calculation, the inclusion of the dividend/remitted amount in the BPA formula should ensure that the shareholder is not subject to tax twice on the same value transfer and that the company does not get a tax deduction for the amount remitted.

IS 24/09 includes a number of useful flow charts and examples, so happy reading!

This article was originally published through the ‘A Week In Review’ newsletter. If you would like to receive Richard’s tax updates every Monday morning, you can subscribe here.